If the term “option greeks” sounds Greek to you, you’re not alone. It refers to insider financial terminology that options traders have been using for decades.
Greeks have little to do with the mathematics of ancient Greece, per se. They do, however, account for a set of financial calculations designed to measure several different factors that can impact the price of an options contract. Greek options intend to help traders make more informed trading decisions.
Option greeks categorized themselves under the following:
- Delta – an evaluation that gauges the probability of an option expiring in-the-money (ITM). In other words, the option’s strike price is below (for calls) and above (for puts) the underlying value of the security
- Gamma – a tool to assess the degree to which the Delta could change if the stock price alters
- Theta – the measure of an option’s potential loss on a given day as it approaches its expiration date.
- Vega – an estimate of how exposed an option is too abrupt price swings in the underlying stock
- Rho – a hypothetical analysis of how changes to federal interest rates might impact an option
The five Greek calculations further explained…
The Delta calculation looks at the degree to which an option price can shift for every $1 change in the price of the underlying index or stock. In other words, a Delta indicating 0.60 means the option’s price hypothetically moves $0.60 for every $1 the stock price moves up or down, based upon the underlying security. As the Delta increases, traders anticipate a larger price change.
Gamma represents the rate of change in an option’s Delta over time. In terms of physics and the calculation of time, Delta accounts for speed, while Gamma signifies acceleration. Like Delta, it projects the rate of change per dollar to the underlying security or index.
The Theta calculation focuses option’s price tendency to decrease per day as it approaches its expiration date. This is also known as “price erosion” or “time decay.” An option’s erosion is nonlinear. The decay increases exponentially as the option moves closer to the expiration date.
According to tastytrade, “Theta measures the rate of change in an options price relative to time. This is also referred to as time decay. Theta values are negative in long option positions and positive in short option positions.”
Vega assesses the potential volatility of the underlying stock while measuring the rate of change in an option’s price per every percentage point change to the underlying security. Vega is not part of the Greek alphabet. It is, instead, made up to suggest V for volatility. The Vega calculation is a tool for predicting how an option’s price will shift with the volatility of the underlying stock.
Rho attempts to predict change in an option’s price for every single percentage point change to interest rates. The calculation indicates how much an option’s price should increase or decrease pursuant to rate changes to the US Treasury Bill.
Several services stream Greeks in the options supply chain and trading windows, so you can watch your preferred lists. Irrespective of which one you choose, an understanding of Greeks is assessing volatility and making good sense of your options.